Is Capitalism 2.0 a Mirage? (Part 1 of 2)

PART 1 of 2

When Lou Gerstner took over IBM at a time of corporate crisis, he was asked if he would chart a radically new direction for the firm. His memorable response was, “The last thing IBM needs right now is a vision.”

For the past several decades, business has had a vision; one so dogmatically defined that we might even call it an ideology—the ideology of Capitalism 1.0. Now that vision has turned toxic. Many agree with Michael Porter that business is now facing a crisis of social legitimacy.

The question is–what to do about it? Does capitalism need a fundamental reframing? Or is the issue more one of execution, about getting along in broader society?

In this two-part blogpost, I’ll examine the case for radical reframing–let’s call it the search for Capitalism 2.0. Part 1 provides background and two approaches to Capitalism 2.0. Part 2 evaluates the results.

REFRAMING CAPITALISM

One answer to the problem of business legitimacy is to re-frame Capitalism. Re-thinking capitalism is as tempting to capitalist ideologues as rethinking Marxism was to generations of socialist ideologues. ‘If “shareholder value maximization” isn’t working, then let’s come up with another encompassing business theory that is even broader than the old one, but that works. Let’s call it Capitalism 2.0.’

Two of our leading thinkers—Michael Porter, with Mark Kramer, and new kid on the block Umair Haque—are attempting an intellectual rebooting of the capitalist operating system. Porter’s concept, contained most recently in an HBR article, is Shared Value. Haque’s new book is called The Capitalist Manifesto.

Can capitalism truly be re-visioned from within? Or is it a closed system whose solutions must come from without? If anyone can square the circle, these authors can. Let’s start by understanding what they’re reacting to.

Capitalism 1.0

The full name of Harvard Business School used to be “The Harvard Graduate School of Business Administration.” In the 1950s, that name was apt. Adam Smith was rarely mentioned—Schumpeter and Hayek, even less.

It was pragmatic, non-ideological. Peter Drucker had just begun to conceive of management as distinct from administration; ‘strategy’ was an occasional term, borrowed loosely from military theorists.

In the 70s and 80s strategy went quantitative, bringing us portfolio management theory, the growth/share matrix and log-scale experience curves.

MBA consultants flooded boardrooms with models in lieu of gray hair. Consulting firms seized thought leadership from the business schools. An ideology was being born.

Capitalism 1.0, circa 1980

Around 1980, the core business ideology saw business as a corporate competitive struggle for dominance and survival. All players—producers, their customers, their suppliers, government and regulators—competed. Winning was defined financially, driven by market share, in turn driven by competitive strategy.

Economists and financial theorists joined the mix in the 1980s. One result was greater emphasis on debt, which led to junk bonds, LBOs, private equity and the S&L crisis. Another was the reign of Alan Greenspan and the Chicago School of Economics, whose contribution to dogma was the idea that markets are largely self-correcting.

As tech boomed, the public caught the bug as well. Wall Street created day trading, hedge funds and IPOs, and the public bought it.

Capitalism 1.5

By around 2006 capitalism’s dogma had become more sharply stated—something like:

Business is the value-creating engine of all society. It works best when left alone. Through creative destruction and the Darwinian efficiency of self-correcting markets, it creates value and wealth for all. All business transactions can and should be expressed in present value cash flows terms. The social purpose of a corporation is to earn a profit, and its proper goal is the maximization of shareholder value.

The dogma had held despite Michael Milken, Marc Rich, the S&L and Long-Term Capital crises, Enron and WorldCom. But then came the financial crisis of 2008.

Several items are striking. Alan Greenspan recanted his belief in Capitalism 1.X. Nearly every Chicago economist (notably excepting Eugene Fama) shifted back in the direction of Keynesian economics; Paul Samuelson says Milton Friedman himself would have done so.

The MBA Oath was created at Harvard in 2008. One of the group’s faculty advisors, Nitin Nohria, became the next Dean of HBS. He believes business needs to be more socially attuned–away from shareholder value maximization, toward broader social responsibilities.

In other words, Capitalism 1.X is under attack as a belief system. What will take its place?

The Search for Capitalism 2.0

Business strategists and economists love elegantly simple models. Many past successes have come via idea home runs—redefining paradigms, thinking outside boxes, changing game rules. Porter and Haque have made powerful attempts to do so, as follows:

Shared Value and the Capitalist Manifesto

Both approaches describe Capitalism 1.X’s failures sweepingly. They indict zero-sum thinking, short-termism run amok, and a systemic inability to link corporate benefits to social costs. If anyone needs a comprehensive statement of what’s wrong, look no further than these two works.

Each work also describes a better end-state; longer time horizons, broader collaboration, comprehensive calculations. Yet the solution, both Porter and Haque seem clearly to say, lies in ideology: in re-framing the tenets of capitalism.

Here is Haque’s version:

The industrial age’s dilemma is unsolvable if we’re still confined to thinking in yesterday’s terms…Escaping the capitalists’ dilemma requires a paradigm shift.

The outlines of an updated economic paradigm…include two fundamental axioms:

…first…through the act of exchange, an organization cannot, by action or inaction, allow people, communities, society, the natural world, or future generations to come to economic harm. [Italics are Haque’s]

Porter is equally didactic:

The purpose of the corporation must be redefined as creating shared value, not just profit per se.

The concept of shared value resets the boundaries of capitalism.

Not all profit is equal—an idea that has been lost in the narrow, short-term focus of financial markets and in much management thinking. Profits involving a social purpose represent a higher form of capitalism—one that will enable society to advance more rapidly while allowing companies to grow even more.

We need a more sophisticated form of capitalism, one imbued with a social purpose. But that purpose should arise not out of charity but out of a deeper understanding of competition and economic value creation…It is not philanthropy but self-interested behavior to create economic value by creating social value.

This all begs some pretty big questions: what exactly do we get with a new definition, a new paradigm, an axiom? Do the authors mean that the single biggest, most critical issue is to fix our thinking? Is it really necessary to have a new paradigm in order to get on with matters?

And even if it is necessary to re-think capitalism–is the re-thinking a sufficient condition for getting the job done? For that matter—can it even be done at all? Can we really stretch “capitalism” so far as to equate social good with corporate self-interest? Or is Capitalism 2.0 really a mirage, a distraction from more mundane but critical ways of changing business?

Tomorrow: Part 2 of 2: Capitalism’s Search for the Holy Grail.